Stock Market Is Betting On a Recession

Anthony Mirhaydari MSN Money August 18, 2011

8/17/2011 5:08 PM ET

By Anthony Mirhaydari, MSN Money

If the stocks and the economy can't get back on track, we're in for a prolonged and painful downturn. The market is betting on recession, but there's reason to believe we'll make it.

Anthony Mirhaydari

Investors felt the burning tinge of panic over the past few weeks as the stock market suffered some of the most dramatic drops in history. By one measure, equities dropped with a ferocity not seen since the 1940s.

Small caps were among the hardest hit, losing more than 20% -- qualifying them for bear market status. The big-cap Standard & Poor's 500 Index ($INX) has completed a "death cross," an ominous term chartists use to describe a downward cross of the 50-day and 200-day moving averages.

Many investors, numb from all they've endured over the past four years, threw their hands up in despair. Mutual funds recorded massive withdrawals as they pulled their money out of the market. Consumer sentiment, as recorded by the University of Michigan, dropped to its lowest level since the data was first recorded in the 1950s.

Would it be a double dip or a new recession?

As I described in "Can anyone fix this economy?", a combination of economic vulnerability, policy bungles and unintended consequences have sapped the strength and optimism developing in the wake of the springtime energy price spike and Japanese disaster.

This fear threatens to pull an already weakened economy -- trudging along with unhealed wounds like 9%-plus unemployment and a dilapidated housing market -- down into a double-dip recession.

If that happens, the logic goes, we'll face a protracted downturn because we have few tools left to resuscitate growth. Given the economic imbalances, excess debt and pure desperation out there -- represented by record long-term unemployment and a record number of Americans relying on food stamps -- it could very well be Great Depression 2.0.

But our fate is not sealed. In fact, there is evidence that savvy Wall Street pros are already playing for a turn, snapping up shares jettisoned by the average investor at a loss with the intent of demanding top dollar later. The actions of those savvy investors suggest that this a temporary slowdown à la 2003, 1998 and 1995 -- all of which marked fantastic buying opportunities.

That's helped stocks push off their lows and move higher after last week's violent, up-and-down swings. The S&P 500 has already regained nearly 8%.

Here's why this do-or-die moment may see the market keep going up -- and how you can ride along with it.

Stocks priced for a dark future

I've hammered away at all that's wrong in my recent columns and blog posts, so I won't repeat myself. Just know that the situation is tenuous. Washington is dysfunctional. Europe, with its imperfect monetary union, is in purgatory. And the United States is trying to reorient itself as a responsible export-led economy but is going about it the wrong way.

The reason the economy is on the brink is that growth in the first half of the year averaged a pitiful 0.8% annual rate. That's well below "stall speed" of around 2% -- the level needed to keep unemployment from rising.

Operating below stall speed also pushes down prices, which makes the problem worse: Lower prices erode corporate confidence and cause consumers to withhold spending, further damaging the economy and lowering prices. It's a negative-feedback loop that throughout history has threatened to pull our economy, whenever it ventured into the sub-2% doldrums, into outright recession.

And now, we have a crisis of confidence that threatens to keep shoppers out of stores and corporate executives from hiring. No wonder the yield on the 10-year Treasury note has dropped all the way down to 2.3% -- a level just off the lows hit in the panic days of late 2008. To put it simply, the bond market is pricing in a deflationary recession.

So is the stock market. David Bianco at Merrill Lynch finds that, based on long-run price-to-earnings comparisons, stocks are trading at levels consistent with a mild recession featuring a 20% drop in earnings and a 2% contraction in the U.S. economy. Depressed valuations have pushed the "equity risk premium" -- the theoretical profit cushion offered to nervous investors for buying stocks over Treasury bonds -- to an all-time high after swelling to levels not seen since the early 1980s.

Overseas markets are also pricing in a dark outlook, according to Credit Suisse. Russian equities are anticipating crude oil falling to $70 a barrel from $88 now. Turkish banks are priced for downward earnings revisions of 17%. South African industrial stocks are priced at a level typically associated with an outright contraction in U.S. factory output. Polish stocks are priced at a level consistent with a 21% drop in German capital goods orders.

I think this bleak outlook has gone too far.

Green shoots of growth

While the economic data have been disappointing, we haven't seen a complete washout.

The ISM manufacturing index, while well off its highs, isn't yet in recessionary territory and remains consistent with 5% earnings growth, according to Merrill Lynch. Core retail sales have been better than expected. Auto sales are strong. Vehicle production is ramping up. Steel output is rising. Initial jobless claims have dropped to levels not seen in months. And interbank lending rates remain low.

There's been good news for consumers, too. Banks are finally loosening credit standards. Loan activity is rising as demand for consumer loans swells for the first time since 2005. Energy prices are falling. Home prices are rising. More high-quality, high-wage jobs are being created. Household incomes jumped 3.5% in the three months through July.

Profits have been strong despite economic head winds. With the second-quarter earnings season nearly wrapped up, S&P 500 companies have reported earnings-per-share growth of 21% over last year, compared with a 15% estimate at the start of the season. Sales growth clocked in at 15% versus 8% at the start. Typically, profit growth turns negative before a new recession.

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Corporate avarice and Wall Street greed are killing us.

1 0ReportSpamLMAO722 hours agoAnother story is 15 million kids living in and below poverty.Thanks Mr. gas pump!Thanks Mr. Government and there band of corporate greedy buddies!Thanks Mr. Wall street, Greedy bankers, fund managers and speculators!This is the next generation that will be scarred for life because of your greed!Keep up the good work or actually the no working & just stealing for personal gain! 1 0ReportSpamyzyzyzyzyzyzyzyzyzyzyzyzyzyzyz3 hours ago

With 20 million unemployed, and probably another 10 million going on public assistance because they have run out of UC benefits, I don't really see why " a reduction in new UC claims" is much of an indicater.

3 0ReportSpamYou're a daisy if you do (Californicator) 4 hours agoDEAR CONGRESS,Last year I mismanaged my funds and this year my family and I cannot decide on a budget. Until we can come to a unified decision that fits all of our needs and interests, we will have to shut down our check book and will no longer be able to pay our taxes. I'm sure you'll understand. Thank you very much for setting an example we can all follow =) 7 0ReportSpamindependentvoter9996 hours agoThe tea party faction in congress is doing the same thing congress did in 1930 and again in 1937. Although it seems counter-intuitive to not make deep spending cuts immediately, deep cuts now will only make the recession (depression) worse. One big difference between now and the 1930s is the safety net we have in place (FDIC, unemployment insurance, Medicare, Social Security). Another important difference is the way the Fed has handled the situation. In this recession, the Fed expanded the money supply and kept short-term interest rates near 0. Back in 1930s, the Fed did just the opposite, which led to deflation and a much deeper depression.When this economic nightmare is over, we will have to curb spending AND increase taxes, no matter who is in office. Let's just hope they do it in a rational way rather than making the issue a political football. 11 10ReportSpamYou're a daisy if you do (Californicator) 6 hours agoAs part of President Obama’s $2.2 million dollar taxpayer-funded bus campaign tour, he’s playing the blame game for everything that is wrong with our economy. In addition to scapegoating Republicans and President Bush for the consequences of three years of Obama policies — a tactic which is obviously getting no traction — he’s now blaming our nation’s current malaise on... "a string of bad luck" Bad luck is not to blame for our current economy, it’s bad leadership! 26 16ReportSpamMooka3366 hours agoWhy do you think the rich keep running up the market and then back out with their profits again and again? They know what we're heading for and their building up their cash reserves. Cash will be king and we'll all be their slaves! 16 7ReportSpamhemispheres6 hours ago

I am a one trick pony. The outsourcing of American manufacturing to Communist China is an insidious death for America.

Buy from Wal-Mart or any other big box retailer and help drive the final nail in the coffin.

Corporate avarice and Wall Street greed are killing us.

28 4ReportSpamasdf09876 hours ago...the things responsible for the current soft spot: the political debacle over the debt ceiling, the threat of a U.S. Treasury default, the European crisis and stock market volatility.The good news is that these negative factors have passed either entirely or are fading.I stopped reading right after that. All the problems magically went away! Who wants ice cream? 5 2ReportSpam9Jr384627 hours agoIts the Market thats killed the economy. By pushing up oil by speculators. Gas runs this country and the economy. They gouged to make a fortune in fast easy bucks at the expense of everyone else.So like many others I could care less if the Market collapses, they done screwed the country. 19 3ReportSpamdomingo (Domingo de la Torre) 7 hours agoFor poor people like myself, if you can, buy one or two old US silver coins a month. I call it the poor mans last chance of surviving. 10 4ReportSpamFrank Morton (Starlight19) 7 hours ago

Only basic change can save us from depression. For a starter we could force our public owned corporations to pay our minimum wages wherever they go. They are making record profits from slave labor and getting tax breaks for outsourcing. When the CEO of Disney made 600 million in salary and God knows what in bonuses he had children working in Haiti for 12 cents an hour.

Our 4 biggest banks have 8 trillion in assets and have been getting billions in 0% loans to play the market. This is insane unless you are a big banker or a wall street billionaire.

All government guaranteed loans should be made directly for a small interest. This would cut student and home buyer's notes by half or more and leave trillions in the hands of our people instead of thieving banks. Why should anyone pay a bank 500k or more for a 200k house when the tax payer backs the loan.

We are in bad need of a government and a banking system that serves the people instead of rapes them. Our capital gains tax where most giant money is made is only 15%. So, the top 1 or 2% take more and more while the middle class declines and poverty grows. This is a certain path for Disaster.

We will demand real change or greed and usury will soon have us in depression and chaos. These pigs and their government will not change without force. They have found out they can get away with anything. We need to quit acting like pawns and peasants. Ten or twenty million in the streets with specific demands may be our only hope for saving America.

26 1ReportSpamdomingo (Domingo de la Torre) 7 hours agoI'd like to add one thing. There is nothing this government can do unilaterally or in conjunction with foreign governments of the developed world to stop the fiasco that is coming. Nothing! 21 4ReportSpamdomingo (Domingo de la Torre) 7 hours ago

Somewhere along the line we inadvertently lost control of our government. It might have been out of blind faith and trust in a government pretending to be the one our Forefathers created, In any case this government is under the control of a corrupt Political Class and its supporters.

Corporate American profiteers dictate Domestic and Foreign policies to further consolidate their wealth and power. They, along with this government, DO NOT have the welfare of the American people at heart, nor do they any longer reflect the Ideals of the American populace.

The lack of jobs, suppressed wages, the failing economy, rising inflation rates, and the vast disparity of wealth between the classes are symptoms of the outrageous abuse Corporate American profiteers, greedy Bankers, and Wall Street manipulators have perpetrated against our Citizens. We all know that, and many of us are feeling the pain.

Approximately 55%/60% are struggling from the effects of a major Recession, about 25%/30% are barely surviving a very real Depression, and the other 10% or so, don't give a rats ****.

What do we do? I don't know of any silver bullets. We either accept to live on bended knees, or fight....

29 1ReportSpamrousseauSC7 hours ago

Get rid of govt's idiotic interference and overwhelmingly burdensome costs and we will make this a decent nation again. Govt craves power, grabs power and never understands that power has corrupted its soul and its thinking.

Big busn, big banks and big govt. care not about the citizens of this nation and must not be given more power, but must be controlled for this nation to survive. Deplete their funding and curb their usurpation of the rights of the citizens of this once-great nation. When liberated, we shall prosper. As the opening sentence of the Declaration of Independence opined, we seek "to insure the blessings of liberty for ourselves and our posterity." Free people can prosper. The Sheriff of Nottingham must be sent home.

Repeal the self-employment tax and small businesses will carry this nation out of enslavement to debt.

16 2ReportSpamBull Rider8 hours agoThe ECONOMY is DONE. Stick a fork in it.The DOW is a place for the rich to play with themselves. 34 7ReportSpamLuke19 hours agoIt is all a house of cards soon to collapse due to unprecedented government spending in Europe and the US. We have spent ourselves into oblivion! Government has doomed us as it continues to get worse every day. 34 3ReportSpamstop the spending9 hours agowhen you go to the store look for made in usa, it will cost more but in the end every little bit helps our country 51 3ReportSpamSomeone9 hours agoidiot... 8 24ReportSpamDown4good9 hours agoBut our fate is not sealed. In fact, there is evidence that savvy Wall Street pros are already playing for a turn, snapping up shares jettisoned by the average investor at a loss with the intent of demanding top dollar later.

This is your idea of market improvement? As you state yourself, these Wall Street traitors (pardon traders) only took these positions with intent to sell for a quick turnaround profit. And what do you suppose will happen to the market when they not only sell their long positions but go short with intent to cover at another profit?

After the DOW’s record volatility earlier this month ended with a 600+ swing to the upside, I noticed many Mainstream Media pundits were championing the idea that investors had recovered their losses from the two prior days. What they never even tried to address is that the market climbed back up on vapor volume and that the profile of the investors who now own the new positions is radically more speculative than the ones before. That likely increased the future risk and instability of the markets overall.

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That's helped stocks push off their lows and move higher after last week's violent, up-and-down swings. The S&P 500 has already regained nearly 8%.

Here's why this do-or-die moment may see the market keep going up -- and how you can ride along with it.

I think this bleak outlook has gone too far.

While the economic data have been disappointing, we haven't seen a complete washout.

Corporate avarice and Wall Street greed are killing us.

I am a one trick pony. The outsourcing of American manufacturing to Communist China is an insidious death for America.

Buy from Wal-Mart or any other big box retailer and help drive the final nail in the coffin.

Corporate avarice and Wall Street greed are killing us.

Our 4 biggest banks have 8 trillion in assets and have been getting billions in 0% loans to play the market. This is insane unless you are a big banker or a wall street billionaire.

Approximately 55%/60% are struggling from the effects of a major Recession, about 25%/30% are barely surviving a very real Depression, and the other 10% or so, don't give a rats ****.

What do we do? I don't know of any silver bullets. We either accept to live on bended knees, or fight....

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Stock Market Is Betting On a Recession

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